And I find it kinda funny, I find it kinda sad
The dreams in which I’m dying are the best I’ve ever had
I find it hard to tell you, I find it hard to take
When people run in circles it’s a very very
Mad world, mad world

The haunting Gary Jules version of the Tears for Fears’ Mad World speaks to me in these tumultuous mad times. It must speak to many others, as the music video has been viewed over 132 million times. The melancholy video is shot from the top of an urban school building in a decaying decrepit bleak neighborhood with school children creating various figures on the concrete pavement below. The camera pans slowly to Gary Jules singing on the rooftop and captures the concrete jungle of non-descript architecture, identical office towers, gray cookie cutter apartment complexes, and a world devoid of joy and vibrancy.

The song was influenced by Arthur Janov’s theories in his book The Primal Scream. The chorus above about his “dreams of dying were the best he ever had” is representative of letting go of this mad world and being free of the monotony and release from the insanity of this world. Our ego fools us into thinking the madness of this world is actually normal. Day after day we live lives of quiet desperation. Despite all evidence our world is spinning out of control and the madness of the crowds is visible in financial markets, housing markets, politics, social justice, and social media, the level of normalcy bias among the populace has reached astounding levels, as we desperately try to convince ourselves everything will be alright. But it won’t.

This assessment is based on her own work, but also on a 2018 report released by the Minneapolis Fed.1 The report showed that both income and wealth growth in the US have been much better for higher-income households in recent decades

Notably, when indexed to 1971 (the year Nixon ended the last link between gold and the dollar) we can see the disparity between the top wealth groups and other groups:

What did we learn [from the Minneapolis Fed report]? This new dataset shows clearly that U.S. wealth inequality is the worst it has been throughout the entire U.S. post-war period. We also know now that the U.S. middle class is even more “hollowed out” than we thought in terms of income, with any gains made by the lower-middle class sharply reversed after 2007.

Indeed, the report concludes: “…half of all American households have less wealth today in real terms than the median household had in 1970.”

A closer look at income data also suggests that income growth has been especially anemic since 2007. Using data from the Census Bureau’s 2017 report on income and poverty, we find that incomes for the 90th percentile are increasingly pulling away from both the median (50th percentile) income and from the 20th-percentile income.2

The household income for the 20th percentile increased 70 percent since 1971, while it has only increased 20 percent at the 20th percentile.

The Federal Reserve has been the main cause of business cycles in America since 1913. For several decades, it has tried to hide the consequences of its policies by enabling easy credit during each recession. As Jonathan Newman wrote yesterday, pouring trillions of dollars into the financial sector obscures the external signs of the recession such as low asset prices and high unemployment and promotes economic malinvestment.

This malinvestment creates the conditions that cause the next recession. Some of the consequences of the Fed’s policies, such as stock market and housing bubbles can be directly attributed to its policies. In other cases, the artificially low interest rates and other “easy money” policies foster an “infrastructure rot” that erodes the efficiency of the American economy, the standard of living of consumers, and eats away at American infrastructure. These effects are difficult to trace back to the Fed’s policies, so let’s concretize some examples to understand how Federal Reserve policies affect America.

At the city level, low interest rates allow cities to fund new public projects such as parks and bridges. While this may seem fine and dandy, all infrastructure projects have a maintenance cost. It’s not sufficient to build a park. One must also have the money to maintain it every year. If there is not enough revenue to pay for maintenance, the park will literally rot until the playgrounds fall apart, the lawns are overgrown, the lights fail, and the park becomes too dangerous for families to play in.

The same thing will happen to streets, bridges, and plumbing. This is one of the ways urban decay happens: easy money policies fund unsustainable urban infrastructure projects which make politicians look good, but end up crumbling a few years or decades later.

Those betting on a fourth bubble of even greater extremes will find their time at bat has come to an end.

The conventional investment wisdom holds that central banks will never let markets decline. This is an interesting belief, given that two previous asset bubbles based on central bank “easy money” both imploded, impoverishing believers in central bank omnipotence.

So perhaps we can say that the conventional investment wisdom holds that any asset bubble that bursts will quickly be reflated into an even more extreme asset bubble. That’s certainly been the history of the past 17 years.

1. Every policy yields diminishing returns as the positive results follow an S-curve.

2. What every trader knows no longer has any predictive power.

3. Policy extremes have become normalized, leaving central banks with unintended and unpredictable consequences should they push even more extreme policies in the next bubble burst.

Radical new central bank policies work wonders in the initial boost phase (see diagram below) because the sums being deployed are so large and the policy is so extreme: quantitative easing / purchase of assets by central banks, for example: never before have central banks conjured trillions of dollars, yuan, yen and euros out of thin air and used this new currency to buy bonds, stocks and debt instruments in vast quantities for eight years running.

The staff of the European Central Bank has now released the new macro-economic projections for the Eurozone and whilst the introduction sounds optimistic about an ever-increasing GDP and a relatively stable GDP growth rate, reading between the lines suggests we could see an extended Quantitative Easing program.

The ECB is probably correct when it claims the economic recovery will remain ‘robust’, but it also mentions the ‘favorable financing conditions’ as one of the main drivers of this economic recovery. This is quite the ‘catch 22’ scenario. The economy is recovering due to the low interest rate policy of the ECB, but without this ‘easy money policy’, the recovery would be either much slower or non-existing at all. Whilst we have heard several voices from ECB committee members the central bank is getting close to the point it will start to increase the interest rates again, the working paper from the ECB staffers is pretty clear on the need for continuous (monetary) support to protect the current economic recovery.

Source: ECB paper

What’s even more intriguing is the fact the ECB’s assumptions are taking an even LOWER interest rate into account. The study was based on the market circumstances and market expectations as of half August, and back then, the market was taking an average 10 year government bond yield of 1.3% in 2018 and 1.6% in 2019 into consideration. However, this has now been revised downward with approximately 10-20 basis points. This could indicate the market has started to price in a longer period of easy and free money.

And that’s an important starting point. As the loans to businesses (and individuals) are priced based on the anticipated ‘risk-free’ interest rate of a government bond, the lower expectations for sovereign debt yields will trickle down to the ‘real’ economy (underpinning the growth expectations), but it’s unlikely this effect will still be noticeable should the ECB reduce its QE program.

The Canadian loonie surged after the announcement, climbing to 82 cents U.S.

The decision reinforces the message that easy money and low-interest rates are coming to an end. Of course, the bursting of Canada’s real estate bubble could reverse direction for the bank, using these recent rate gains as leverage to cut rates in order to “stimulate” the deflating economy.

But until then, analysts are expecting more rate hikes since many have confused consumer indebtedness and rising prices as economic strength.

The Bank of Canada won’t confirm these predictions since, according to the central bank’s statement, price controls on interest rates are, “predetermined and will be guided by incoming economic data and financial market developments.”

Of course, the Bank of Canada isn’t clueless when it comes to higher rates and indebted Canadian households. In the rate hike statement, the bank promised that “close attention will be paid to the sensitivity of the economy to higher interest rates,” given “elevated household indebtedness.”

The bank’s next scheduled rate-setting is Oct. 25.

All in all, today’s announcement puts interest rates back to where they were in January 2015, before Poloz made two surprising “emergency rate cuts” to deal with falling oil prices.

The head of Germany’s largest commercial bank warned of the fallout from cheap money, cautioning against using the strong euro as a justification for printing more.

Bloomberg reports that the Deutsche Bank Chief Executive Officer John Cryan called for an end to the era of cheap money in Europe, saying that the prolonged period of rock-bottom interest rates is starting to inflate asset bubbles and putting the bank at a disadvantage to U.S. rivals.

“We are now seeing signs of bubbles in more and more parts of the capital market where we wouldn’t have expected them,” Cryan said, adding that the interest-rate policy has been partly responsible for the decline in earnings at European banks.

“I welcome the recent announcement by the Federal Reserve and now also from the ECB that they intend to gradually bring their loose monetary policy to an end.”

Low interest rates, money printing and a penalty charge for hoarding cash have been at the heart of attempts by the central bank to reinvigorate the 19-country euro zone economy in the wake of the 2008-09 financial crisis.

Reuters reports Cryan told a room full of bankers in Frankfurt on Wednesday, a day before the ECB’s governors meet to discuss policy, that:

“the era of cheap money in Europe should come to an end – despite the strong euro.”

Cryan also explained how ECB policy (relative to The Fed) has disadvantaged European banks…

“U.S. banks enjoy a competitive advantage due to the local interest rate environment,” Cryan said.

Too much of economic growth and the accompanying bull market in stocks is the result of financial engineering. Increasingly, companies seek to improve earnings or increase their share price by means that are not necessarily directly linked to their actual business.

Companies have increased the use of lower-cost debt financing, taking advantage of the tax deductibility of interest. In private equity transactions, the level of debt is especially high. Complex securities have been used to arbitrage ratings and tax rules to lower the cost of capital.

Major benefits appear to have accrued financially to corporate insiders, bankers, and consultants.

Mergers and acquisitions as well as various types of corporate restructurings (such as spin-offs and carve-outs) have been used to create “value.” Given the indifferent results of many such transactions, the major benefits appear to have accrued financially to corporate insiders, bankers, and consultants.Share buybacks and capital returns, sometimes funded by debt, have been used to support share prices. In January 2008, prior to the global financial crisis, U.S. companies were using almost 40% of their cashflow to repurchase their own shares. Ominously, that position is similar today.

Tax arbitrage, especially by international companies operating in multiple jurisdictions, has increased post tax earnings. The use by many companies of special vehicles in low tax jurisdictions, like Ireland, evidences this trend.

Some companies have used trading to increase earnings. Oil companies can make money from trading or speculating in oil, for example. Accordingly, they can make money irrespective of whether the oil business is good or bad or the price of crude is high or low, profiting from uncertainty and volatility. It is not even necessary to produce, refine, or consume oil to benefit from its price fluctuations.

The first US interest rate increase since June 2006 is a pivotal moment for the global economy, launching what Mohamed El-Erian, Chief Economic Adviser at Allianz, calls the “great policy divergence,” with repercussions in every region and financial market. The impact will be particularly powerful in emerging countries, where currencies are vulnerable to a rising dollar and tightening liquidity conditions in the US. Project Syndicate’s commentators – some of the world’s preeminent economists and policymakers – have examined the issue from four broad angles.

What is the immediate and longer-term outlook for US monetary policy?

The Fed’s leaders have repeatedly said that they plan to raise interest rates much more slowly than in previous periods of monetary tightening. Such assurances from central bankers cannot always be trusted, but Fed Chair Janet Yellen’s promises to move more gradually than in the past are credible, because the Fed is genuinely determined to push inflation higher and to ensure that it never again falls much below 2%.

Nobel laureate Joseph Stiglitz provides further grounds for discounting the likelihood of faster tightening. Instead of trying to control inflation, according to Stiglitz, the Fed’s main concern now is to reduce unemployment and counteract inequality. To do this, the Fed must continue to stimulate the US economy with easy money. Even the quarter-point rate hike that the Fed’s just announced is, in Stiglitz’s view, dangerous and premature.

Moreover, while the Fed’s official responsibility is to manage the US economy, its leadership fully understands the international impact of Fed decisions. Thus, Harvard’s Carmen Reinhart, an authority on global debt crises, believes the Fed will “favor gradualism” to avoid wreaking havoc in emerging economies that are overloaded with dollar debts. In a related argument, Barry Eichengreen, the Berkeley economic historian, suggests that US monetary policy is now effectively “Made in China,” because China’s efforts to stabilize the renminbi have already tightened US monetary conditions by the equivalent of the quarter-point rate hike expected on December 16.

Through the door there came familiar laughter
I saw your face and heard you call my name
Oh, my friend we’re older but no wiser
For in our hearts the dreams are still the same
Those were the days

– “Those Were the Days” by Gene Raskin

POITOU, France – Yes, they were good years… 1980-2015. We laughed. We cried. We got married. We raised children. We bought houses. We made money.Whose life has not been improved since the end of the 1970s?

Reagan’s “Morning in America.” Then the Clinton Years. Finally, George W. Bush’s “Fin de Bubble” era. Who is not older and better off (or at least older) than he was when the era began?

Should we just stop there, happy to have had such a wonderful time together?

Today, the Dow opens at 17,867 points – not far from its all-time high. And about 1,180% higher than it was 35 years ago.

A man would be fool to question his happiness in marriage; would he be so foolish to wonder about the bliss afforded by such a bull run?

Vanishing Capital
The press was unanimous as to what happened yesterday: “U.S. Stocks Slip on Yellen’s Testimony.”

What was it about her testimony that caused investors to think that their stocks may be less valuable at 4 p.m. than they had been at 9 a.m.?

“Yellen hints at December rate hike.”

Investors are no dopes. They know the fix is in. The value of a stock is no longer determined by honest commerce. Now, it is a feature of finance – specifically, the rate of interest the Fed pays commercial banks on their excess reserves.

It’s always interesting to see a long term chart that reflects your real life experiences. I bought my first home in 1990. It was a small townhouse and I paid $100k, put 10% down, and obtained a 9.875% mortgage. I was thrilled to get under 10%. Those were different times, when you bought a home as a place to live. We had our first kid in 1993 and started looking for a single family home. We stopped because our townhouse had declined in value to $85k, so I couldn’t afford to sell. In 1995 I convinced my employer to rent my townhouse, as they were already renting multiple townhouses for all the foreigners doing short term assignments in the U.S. We bought a single family home in 1995 with the sole purpose of having a decent place to raise a family that was within 20 minutes of my job.

Considering home prices on an inflation adjusted basis were lower than they were in 1980, I was certainly not looking at it as some sort of investment vehicle. But, as you can see from the chart, nationally prices soared by about 55% between 1995 and 2005. My home supposedly doubled in value over 10 years. I was ecstatic when I was eventually able to sell my townhouse in 2004 for $134k. I felt so smart, until I saw a notice in the paper one year later showing my old townhouse had been sold again for $176k. Who knew there were so many greater fools.

This was utterly ridiculous, as home prices over the last 100 years have gone up at the rate of inflation. Robert Shiller and a few other rational thinking people called it a bubble. They were scorned and ridiculed by the whores at the NAR and the bimbo cheerleaders on CNBC. Something smelled rotten in the state of housing.

Today we will take a look at both Whiting Petroleum (WLL) and Continental Resources (CLR) as far as their Bakken economics. Overall the numbers will show that, despite claims of low cash costs per MBOE ($16 or so for CLR) and high IRRs on $60 WTI, the facts say otherwise. In addition, the analysis will show how very high depletion rates combined with falling rig counts spells trouble for Bakken production growth despite better efficiencies per well. The analysis will be based on April presentations of both companies from which the graphs below are taken. I should note these economics are not much different from Eagle Ford, the second most prolific addition to US production growth in past years.

Firstly one must understand that the easy money via QE from the Fed and zero interest rates allowed many shale players to burn free cash flow while showing operationally net of capital expenditures (which were funded by cheap flowing monies via FED) cash generation. To be clear, that model is now broken as the era of free Fed money appears to waning as both QE, and soon, zero rates become a thing of the past. The cost of capital is no longer falling but is now rising through higher bond yields and/or lower stock prices.